Lowballing LIBOR May Cost Pensions Plenty

According to Wall Street Journal reporter Carrick Mollenkamp ("Libor Surges After Scrutiny Does, Too - April 18, 2008), the British Bankers' Association is moving ahead to investigate the veracity of self-reported cost-of-funds numbers. The fear is that banks are paying more to borrow in the short run than they want to admit. If peers discover the truth, bank borrowers may find themselves at a competitive disadvantage. Non-borrowers will feel the pinch too as will swap and over-the-counter fixed income option counterparties and those trading the Eurodollar futures contract. The London Interbank Offer Rate ("LIBOR") is a common base rate for most short-term loans and derivative instrument contracts.

American regulators are worried too as market pundits predict that U.S. dollar LIBOR rates are likely to spiral. Just last week, three-month LIBOR loan rates rose to 2.8175% per annum, up from 2.7335%, "the biggest increase since the three-month rate rose 0.12 percentage point on August 9" when BNP Paribas prevented investors from withdrawing money from several of their funds. The current level is reported at "its highest" since March 13 when news came out about Bear Stearns.

A rising LIBOR makes swap-driven Liability-Driven Investing ("LDI") strategies more expensive for Fixed Rate Receivors - Floating Rate Payors. In addition, if quarterly checks indeed differ from estimated projections, pensions may eschew LDI strategies as too difficult to evaluate for accounting or risk management purposes.

Interestingly, quotation problems seem to be contained to U.S. dollar LIBOR situations and not other currencies such as the Euro.

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Pension Risk Matters - October 15, 2008 2:05 AM
Long accepted as a key rate benchmark, the London Interbank Offer Rate ("LIBOR") may be replaced by something else if a current deal is a trendsetter. According to Bloomberg reporter Cecile Gutscher, Electricite de France SA will repay inter...
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